Analysis of Comovements between Exchange Rates and Stock Prices:The case of China and Japan

Deregulation in exchange rates and international capital flow may generate a comovement between exchange rates and stock prices of a country.This study conducts a theoretical analysis of the transmission mechanism with interest rates as the intermediate variable.Empirical results show a significant long-run negative association between foreign exchange rates and stock prices.For China,the long-run Granger causality runs from Shanghai Stock Index to RMB rates.The lessons of Japan suggest that positive effects of RMB appreciation on share prices can be followed with serious consequences upon the burst of stock market bubble.A gradual approach may ensure the initiality,controllability and graduality of the exchange rate reforms.China should control the pace of the reform progress according to the changing international and domestic economic situations,tighten restrictions on abnormal capital inflow and strengthen the market supervision,in order to build an open,fair and transparent securities market as well as the institutional fundamentals for RMB internationalization.